"What is needed for a lasting recovery
Published: June 18 2009 19:17 | Last updated: June 18 2009 19:17
In 2007, worried about the growing size of current account imbalances, the International Monetary Fund organised multilateral consultations to see what should be done about it. There was wide agreement that the solution was conceptually straightforward. To caricature: get US consumers to spend less. Get Chinese consumers to spend more. This would be good for the US, good for China, and good for the world. (There were messages to the other players – Japan, Europe, Saudi Arabia – but they were less important.)
Good for the US: it was clear even then that the consumption binge US consumers had embarked on was unwise, and that many of them would face problems in retirement. Good for China: it was clear that much Chinese saving reflected the absence of a social safety net. Providing health and retirement insurance was desirable on its own, and would naturally lead consumers to spend more.
Good for the world: combined with an appreciation of the renminbi relative to the dollar, the changes in consumption patterns could maintain full employment in both the US and China, and decrease current account imbalances. Lower consumption in the US would be offset by higher US net exports. Higher consumption in China would be offset by lower Chinese net exports. The US current account deficit would be reduced, and the Chinese current account surplus would fall. As this orderly process of adjustment took place, and imbalances were steadily reduced, the risk of a sudden collapse of the dollar would decrease. And the world would be in much better shape.
It was an impressive piece of global macroeconomic planning. But, at least until the crisis, not much happened. Optimistic US consumers were just not in the mood to change their ways. Given the success of its export-led growth strategy and concerns about the need to maintain employment growth, the Chinese government continued to give priority to exports.
As if to prove the sceptics right, the crisis itself was not triggered by global imbalances. The dollar did not collapse, as feared. And, since the beginning of the crisis, dealing with global imbalances has gone down the priority list. Dealing with the state of the financial system has been, rightly, the focus of attention.
As the crisis evolves, however, and we start looking at eventual recovery, the issue of global imbalances is likely to return to the fore. Again, a central role will have to be played by the US and by China.
Half of the adjustment suggested in the multilateral consultations is coming into play: US consumers are, at last, cutting their spending. They have lost a lot of wealth, and it will take them many years of additional saving to undo that loss. And, more importantly, they have learnt a more general lesson. The world is more risky than they thought. Stock and housing prices can go down, and go down a lot. Planning for retirement may require saving a lot more than was thought wise before the crisis hit.
The main unknown is about the other half of the adjustment. In response to the crisis, China has embarked on a major fiscal expansion, with a focus on investment rather than on consumption. This was the right policy given the need to increase spending quickly, but this increase in investment can only last for a while. The question is whether, as time passes, China will allow an increase in consumption. If it does, the 2007 master plan may come into being. Larger US net exports will replace US consumption and help sustain the US recovery. Larger Chinese consumption will compensate for lower Chinese exports and allow China to maintain high growth. The world recovery can proceed and we can emerge with a more balanced world economy.
Will this scenario naturally play out? Maybe, maybe not. China has announced ambitious healthcare reform, which goes in the right direction. But the export-led model that China has so successfully followed will not be abandoned overnight. And, looking beyond China, the crisis mayhave convinced many countries to accumulate even more reserves, thus running even larger current account surpluses. These countries will not be eager to appreciate against the dollar, and so allow for larger US net exports.
What if there is no rebalancing? Without sustained domestic demand and higher net exports, the US recovery may weaken once the fiscal stimulus is phased out. In normal times, monetary policy could help, by lowering interest rates and increasing demand; these are not normal times and rates can fall no further. Thus, there will be heavy pressure on the US government to maintain a strong fiscal stimulus for as long as private demand is weak, and this may lead to larger and longer deficits than would be wise. While strong fiscal stimulus was and still is needed to fight the crisis, it cannot go on forever; at some stage, debt dynamics become unsustainable, markets react and fiscal deficits become counterproductive. Neither a weak US recovery nor unsustainable US debt dynamics are likely to be good for the world. The first probably means a stalled world recovery; the second probably means mayhem in financial markets.
Sustained recovery requires decreased domestic US spending and increased domestic spending in China and much of the rest of the world, together with adjustments in exchange rates. Global co-operation played a crucial role in the past year in avoiding a worse crisis. More global co-operation, with the US and China playing a leading role, is now needed.
The writer is chief economist of the IMF"